Standing Committee A

[Mr. Joe Bentonin the Chair]
(Except clauses 13 to 15, 26, 61, 91 and 106, schedule 14, and new clauses relating to the effect of provisions of the Bill on section 18 of the Inheritance Tax Act 1984)

Clause 103

Real Estate Investment Trusts

Question proposed, That the clause stand part ofthe Bill.

Edward Balls: I will just make a short set of opening remarks about the clause as we begin the discussion on clauses 103 to 146, which will introduce the new system of UK real estate investment trusts—UK REITs. The debate follows that in Committee of the whole House on clause 106, during which the Under-Secretary of State forHealth, my hon. Friend the Member for Bury, South (Mr. Lewis), my predecessor as Economic Secretary, gave a detailed account of the Government’s rationale for introducing UK REITs legislation. I am sure that we shall cover today all the points that he made in that debate, so I will not go over that ground.
There has been a lengthy period of consultation—I think that for some hon. Members it has been frustratingly lengthy. Our main aim is to ensure that we introduce a system that has not only widespread support in the House but support and applicability in the wider world. Following the consultation, with two consultation documents in the past couple of years, and the Government’s detailed responses to the consultation in recent months, the indication from the market is that companies are getting ready for the new regime. That is an encouraging sign. It is not possible to achieve consensus in every policy area, as we said in our debate on another matter on Tuesday. I hope that, following the detailed debates that we will have on amendments today, there will be a consensus about the right way forward for the UK REIT regime.

Mark Francois: As the Economic Secretary has said, we now come to the clauses in part 4 of the Bill, dealing with the regime to introduce real estate investment trusts—REITs—into the UK. I would like to make a few brief introductory points on part 4 before we debate the clauses in detail. As I pointed out on behalf of the Opposition on Second Reading, we welcome in principle the introduction of a REIT regime into the UK. It is an initiative that we have been advocating for some time, so we seek to work constructively with the Government to ensure that the regime is in good order when it commences formally in January 2007.
We accept that there may be some changes to the scheme in light of experience post-launch. For instance, we welcome the Government’s commitment to reviewing whether REITs can list on the alternative investment market, which we advocated in the sitting of the Committee of the whole House on 3 May, to which the Economic Secretary referred. However, we are particularly keen to avoid circumstances that would lead to a major rewrite of the legislation shortly after the launch. In other words, REITs cannot be allowed to become another SIPPs—the case of self-invested personal pensions. We therefore welcome the Government’s amendments to clause 116 and the contingent amendments to clause 130, and their intention to delete clause 143, which was always an unnecessary requirement for reasons that we shall come to in due course. We have residual concerns about some of the measures in the proposed REITs regime, not least that the system appears to do comparatively little for the residential property sector.
With those brief introductory remarks, I look forward to debating the details of part 4 with the Economic Secretary and the rest of the Committee.

Julia Goldsworthy: I too wish to make some introductory remarks as we begin our discussions on part 4. It is important to put it on the record that we welcome the Government’s proposals and can add to the consensus that has been registered. Although REITs are increasingly used in many countries to attract investment into the property industry, they are a new concept for the UK and it is important that we go through all the proposals thoroughly. It is a reflection of the Government’s consultative and co-operative approach on the proposals that they have been so broadly welcomed, not only by the property industry, but in this place.
As a result, as the Economic Secretary says, many existing commercial property companies are tripping over themselves to convert to REIT status as soon as they are able. That will result in greater opportunity for individuals among the public to invest in the property industry without exposing themselves to the risk of holding a property individually.
The consultative approach that I mentioned contrasts with that taken on other issues in the Bill. It is no coincidence that that consultative approach has resulted in largely workable proposals, while the industry has proclaimed pretty unanimously that the proposals for changes to trusts, put forward without any consultation, are unworkable.
Although the 40-odd clauses contain many positives, I should like to highlight one thematic concern that relates to the extent to which the proposals will result in increased investment in the residential property sector. We know that the existing listed commercial property companies intend to convert en masse as soon as they are able, but how many residential property companies does the Minister estimate will make the switch in initial years, and how many will be eligible to do so?
From recent media reports, we know that the Grainger Trust, Britain’s only listed residential property company, will not convert to REIT status because it does not fulfil the criteria outlined in the proposals. Its main business is with tenanted properties—old homes occupied by former state workers paying low capped rents. The company makes its profits by selling those properties when the tenant moves, which means that it does not meet the interest cover test. It is affected also by provisions relating to trading companies, under which it would pay 30 per cent. corporation tax on capital gains when it became a REIT. However, companies holding investment property will pay no such charge.
During our discussion of later clauses, we shall see difficulties relating to companies wishing to set themselves up from scratch as REITs rather than converting from an existing company. Given that there are not so many residential property companies, there is an initial disadvantage to encouraging investment in that sector.
However, on a slightly more positive note, there have also been reports that 17 housing associations, working closely with the Joseph Rowntree Foundation, plan to put together a consortium to convert to REIT status and provide greater investment in that residential sector. I welcome that, although there are clearly mixed messages about how attractive REITs will be for the purposes of getting investment into the residential property sector.
I should appreciate any light that the Economic Secretary can shed on how he expects participation in REITs to break down in terms of new trusts and converted companies and of the split between residential and commercial properties. What more does he think his Department must do to encourage REITs to expand more into the residential sector, where greater investment would clearly bring the greatest benefit?

Edward Balls: The hon. Member for Rayleigh (Mr. Francois) is right to say that the consultation took some time and that the Opposition have been pressing for faster progress during the past two or three years, although the Government put the issue on the agenda even further back than that. I do not think that we should apologise at all for the fact that we have taken the time to get things right. The hon. Gentleman said also that we must have an open mind about future developments, while doing our best to get all the detail of the clauses in the Bill right.
It is important that we should be able to respond to changes, developments and new information, and we went out of our way to provide the public and Opposition Members with the details of the regulations last week—very early, given that those details do not have to be completed until the autumn, in time for the REIT regime to start next year. Furthermore, clause 103 includes a purposive element to make it clear that we expect companies to abide by the spirit of the intent behind the Bill.
As for what the hon. Gentleman said about AIM, the Under-Secretary of State for Health, my hon. Friend the Member for Bury, South, said in Committee of the whole House that
“an extension of the regime to include companies traded on AIM would not meet the Government’s objectives at this stage.”—[Official Report, 3 May 2006; Vol. 446, c. 1045.]
The reasons for that were fully debated. He also said:
“We are willing to consider any consequence of market developments and what we are learning about what happens in the international community. We must always be willing to consider whether we want to change the regime in the interests of the market and clearly not to the disadvantage of the Exchequer. Of course, we can give a commitment today, in the context of the concerns that have been made or suggestions to do things slightly differently, that we will keep the situation under review.”—[Official Report, 3 May 2006; Vol. 446, c. 1041.]
That is what we will do.
As for what was said by the hon. Member for Falmouth and Camborne (Julia Goldsworthy), an amendment has been tabled to clause 107, which deals in particular with residential property. I intend to respond to such matters when we discuss that, although they may arise earlier.
The hon. Lady referred to the Grainger Trust. Over the past few weeks, several significant top-listed companies, including British Land, Hammerson, Land Securities, Brixton and Great Portland Estates, have announced that they will be converting to the UK REITs regime from next January. The main focus of their business is commercial property and together they have valued more than £25 billion worth of assets. Those companies, along with the British Property Federation and others, have also been significant participants in the consultation process. The fact that they are now willing to start the process of being ready for conversion shows that the consultation has worked and that, at this stage, we have a good chance of a thriving REITs regime from next January.
The only FTSE-listed company with a major portfolio of residential assets is Grainger Trust, which announced on 5 June that it would not be converting. The reason is that the business model that it employed is not the kind of business model that we aim to support under the Bill. It is a business model whereby a substantial proportion of income is derived from renting out property. Grainger said that it will not be converting because it will not meet the interest cover test, as a large part of its business involves not deriving income from renting out property, but buying tenanted properties with low-capped rents, which have insufficient rental income to its interest payments, and then making a profit through selling the properties on at a gain when the occupiers move.

Mark Francois: The Economic Secretary has just made an extraordinary statement. The whole REITs regime is about renting property and the fact that it is residential property is the key point.

Edward Balls: We shall debate residential property when we reach clause 107.
I was saying that Grainger does not derive its income from renting property. A substantial proportion of its income comes from making gains on the sale of property. The actual income that it derives from the renting of property is low. Even though as part of the consultation we have substantially reduced the interest cover test, it is still a test that would not allow Grainger to pass because it does not derive the majority of its income from renting out property. It instead goes about a different business seeking to make the bulk of its returns from capital gains on the appreciation in the value of the property.
As we made clear all along in the consultation and have debated many times, that is not the business model that we are trying to support under the Bill. We do not think that it will have a significant impact, and the FT article to which the hon. Lady referred acknowledged that both Grainger and other companies, including housing associations, are considering floating new residential UK REITs from next year.

Celia Barlow: I welcome the Government’s proposition to introduce real estate investment trusts. As the majority of the industry recognises, the Bill provides a practical framework for that and the idea has a high probability of being a success, as recently seen in other countries such as the United States and France. I was encouraged to hear the hon. Member for Rayleigh welcome the proposals. The financial markets also seem to regard them as a great investment opportunity, but our primary concern should be somewhere else.
The area that I represent is suffering from a severe shortage of available, particularly affordable housing. Furthermore, Hove has the highest proportion of houses in multiple occupation outside London. My argument is that we should not lose sight of the original purpose, which is to provide better housing. The Government have decided to make REITs available to residential and commercial property. I support that idea.
In the Second Reading debate on 24 April, the right hon. Member for North-West Hampshire (Sir George Young) argued that REITs should focus on residential property. What he left out was that the Conservative scheme of housing investment trusts (HITs) was a failure and had never taken off. The benefit to the residential housing market was zero as the regulations were too restrictive. I am glad that the Government have not repeated that mistake. The example of HITs shows the risk of making one investment vehicle available instead of giving the industry the flexibility to invest in various projects. That wise decision notwithstanding, we should not lose sight of the fact that REITs were originally considered an opportunity to channel money into more residential housing projects.
In 2003, the interim report of the Barker review stated that
“in recent years, direct institutional investment in residential property is very low in the UK...Given the benefits that may result from greater institutional investment, and the role REITs play in other countries’ housing economies, there may be merit in the Government looking at ways to promote greater interaction between institutional investors and the residential property market.”
In recent debates in the financial press, which have been referred to, and the policy documents issued on the scheme, the purpose of the legislation seems to have taken a back seat. I do not need to stress how badly my region of south-east England is affected by a shortage of decent and affordable homes. Any solutions to improve the shortage of homes must be welcome.
Will my hon. Friend clarify the suggestion that REITs in the residential sector might not be popular? Will he clarify the scope of the new REITs and the fact that they are designed to provide an opportunity to invest in better housing provision, not just more housing?

Rob Marris: I welcome you to the Chair, Mr. Benton. Following on from that excellent contribution from my hon. Friend the Member for Hove (Ms Barlow), could the Economic Secretary say what research the Government have done on whether REITs will increase, decrease or have no effect on the price of residential property?
One of the things that plagues us in the UK, particularly in the south-east of England but all over the country as well, including hot spots in Scotland and Wales, is the shortage of properties. Together with a growing population, that has led to high residential property prices. If REITs are introduced and a flood of money goes into the residential property market, for example as REITs start buying up residential properties to rent out, I am concerned that that will exacerbate the problem. There will be higher house prices and nothing will be done to address the underlying shortage of residential properties within the UK.
First, does the Economic Secretary think that the introduction of REITs will affect residential properties in the UK? If so, in what way? Secondly, does he think that REITs will encourage more building and a greater supply of residential properties within the UK?

Edward Balls: We will have other opportunities to provide some of the details as we go along. As we made clear in the debate on the Floor of the House, REITs are a way of improving the efficiency of the housing market and encouraging more people to invest in housing by using pool vehicles. We hope that they will allow for a greater volume, efficiency and flexibility in the use of that investment.
REITs are part of a wider strategy to encourage more investment in UK housing. That is why they were one of the recommendations of the Barker review, which reported in 2003. It recommended that we pursue the UK REIT regime precisely to deliver the objectives of my hon. Friends. Those included improving the supply of housing in the UK and therefore tackling the problem of the substantial increase in the price of housing relative to earnings for first-time buyers—a substantial problem facing many families, particularly in the southern parts of our country but all across the country. The Barker review and the Government, which endorsed the conclusions of the review, both consider it to be fundamentally a problem of a lack of housing supply. I do not think that the REIT regime, in and of itself, impacts on the volume of the supply of housing as opposed to market efficiency. Therefore, we do not think that introducing UK REITs, in and of itself, will have a significant impact on aggregate prices. However, we hope that REITs, along with the other reforms that we are introducing that originated in the Barker review, will have a significant impact over time on the supply of available UK housing and on prices for first-time buyers and others, thereby having a beneficial impact on the stability of the British economy and the affordability and fairness of our housing system.

Rob Marris: I understood the Minister to say that he did not think that REITs would themselves have an impact on the supply of housing, although other Barker review reforms might. Although I am not an economist, it seems to me that greater investment in housing without an increase in supply is likely to lead to increasing prices unless the investment is in things such as refurbishment.

Edward Balls: The fundamental thrust of the Barker review is to increase the supply of housing in our country both so that more houses are available, and so that there are more houses at an affordable price. The review has a number of different strands: reforms to the planning system, the management and planning of infrastructure and the availability and supply of social housing.
Kate Barker recommended as part of the overall package that we should also consider ways to increase the efficiency of the building industry, and she made some recommendations about skills and planning for skills. She also made recommendations about the efficiency with which people are able to invest in the commercial property sector. In our view, that package of measures, which we are taking forward, will reduce prices for first-time buyers and increase the supply of housing.
As an economist, I bow to the legal and economic knowledge of the hon. Member for Wolverhampton, South-West (Rob Marris). He is right: if we increase the supply, we ought to be able to reduce the price. That is our intention. What I said was that I did not think that the UK REIT regime, in and of itself, would increase the overall supply of residential housing, but I thought that it would improve the market’s efficiency. But the Government think that the overall package will have a positive impact, implementing the Barker review.

Brooks Newmark: If I can throw a business man’s perspective into the witches’ brew of an economist and a lawyer, to help the Economic Secretary out, I would argue that an increase in supply of capital into an attractive REIT market could push down the cost of capital and the price of houses. The profit motive is what drives REITs. At the end of the day, more capital flowing into an attractive REIT regime could, hopefully, push down prices.

Edward Balls: I appreciate the hon. Gentleman’s economics lesson, and I shall endeavour to reflect on it further.
The UK residential private rental sector is a rather small part of the overall housing market. To make a significant impact on supply and price, we must consider building houses in the purchase market. That is the thrust of the Barker review.
Several hon. Membersrose—

Edward Balls: I will answer them one by one.
As I said at the beginning, the prospect of a consensus on REITs today is encouraging. It is worrying that we still have some way to go before we come anywhere near a consensus on implementation of the Barker review. We had only to listen to Prime Minister’s questions yesterday to hear the Conservative party’s concerns about Government proposals to increase the supply of housing, because although those proposals might make it easier for first-time buyers to make a purchase, they are causing concern to some Conservative Members’ constituents. Indeed, if one does a short survey of the comments seen on Conservative Members’ websites regarding constituents’ views on particular development opportunities, one finds that we are some way short of a consensus, certainly with Opposition Members, on those issues. [Interruption.] Indeed, the shadow Housing Minister has not been shy of objecting to a few different housing developments.
So we have some way to go, but the Barker proposals more broadly will have an impact on those wider supply issues. As to its impact on residential property, the REIT regime is much more about making the market work in a more efficient, open and transparent way, which will benefit investors and the City of London. I hope that that clears up the point.

David Gauke: I note the Economic Secretary’s comments about supply, but I think the hon. Member for Wolverhampton, South-West was asking about the effect on demand. I should be grateful if the Economic Secretary would clarify the point about the impact of REITs on the demand for property.

Edward Balls: The fundamental problem in Britain is that of supply. What drives the price is restrictions on supply over a long period, and what will affect the aggregate price will be finding ways—with consensus—to remove restrictions on the overall supply of housing. Given the size of the sector we are discussing, the demand-side effects are trivial in comparison with the much bigger overall effects of the supply side, and would not wash in any sensible comparison.
With apologies to my hon. Friend the. Member for Wolverhampton, South-West, it would not take us very far to be drawn into an arcane debate about how things may actually work, which will depend on factors relating to particular sets of elasticities. In the end, the big issue in terms of price is supply, and so far as the impact on the residential sector is concerned, UK REITs will not tackle the supply issue. The decisions need to be made elsewhere.

Colin Breed: We all recognise the supply-demand situation. Obviously, REITs will make a contribution, whatever it is, and the consequences may not be clear for a little while. However, as to the cost of housing, especially residential housing, it is the cost of land that is the problem. Available land is getting scarcer, particularly in my part of the world where there are more and more areas of outstanding natural beauty and more planning restraints, therefore the cost of land is increasing. If there is a significant increase in the money available because of REITs, would that not enable land prices to rise? If that happens, we will not get any further forward.

Edward Balls: I refer the hon. Gentleman to the answer that I gave to the hon. Member for South-West Hertfordshire (Mr. Gauke), as the same point applies. In respect of the REITs regime, its impact on the residential and private rented sector, which will be the same in Cornwall and Devon as it is in the rest of the country, will not be large enough for changes at the margin to have a significant effect on the overall level of land and house prices. Therefore, although I understand the hon. Gentleman’s concerns, they need to be addressed to other routes in the planning system and the way in which the housing supply is managed and improved.
We are having a broad debate about housing policy, which is very interesting and important, but it is not particularly relevant to the UK REITs legislation which, in and of itself, will not solve the problem; that needs to be solved by measures elsewhere. With your permission, Mr. Benton, we should agree the clause and move on.

Question put and agreed to.

Clause 103 ordered to stand part of the Bill.

Clause 104

Property rental business

Question proposed, That the clause stand part ofthe Bill.

Mark Francois: Before we debate the clause in detail, I welcome you to the Chair, Mr. Benton. I want to take this opportunity to raise one of the key issues relating to the REITs regime as it is currently proposed: namely, that the regime is written principally for commercial property and seems likely to do much less to stimulate the residential property market in the UK. That theme cropped up in our discussion on part 4 this morning. By way of example: a number of the principal commercial property companies in the United Kingdom announced recently that they are planning to convert wholly or partly to REIT status. Those companies include British Land, Hammerson and Land Securities, but the list is growing.
Few, if any, of the residential property companies have declared an intention to convert to REIT status, however. So I am seeking to open a debate about that apparent weakness in the regime, to investigate why that might be and to suggest at least a few areas that might be worthy of consideration in order to try to remedy the situation. Given the background in housing and finance of my right hon. Friend the Member for North-West Hampshire, I suspect that he might also have something to say on that subject, if he is lucky enough to catch your eye at some point, Mr. Benton.
In view of the current balance between commercially and privately rented property, that is a particular issue in the United Kingdom property market. According to the Royal Institution of Chartered Surveyors, the private rented sector currently accounts for one in ten households in the UK. A 2002 report produced jointly by Shelter and the Joseph Rowntree Foundation entitled “Private Renting: A New Settlement” estimated that investment in excess of £1 billion per annum is required to maintain the private rented sector at that level of market share, as it were. To enlarge that markedly—the report did not define that—would require investment in the region of £3 billion pounds per annum.
The vast bulk of private sector investment in the UK property market, however, is still weighted heavily in favour of the commercial rather than the private residential sector, which is in marked contrast with a number of our European counterparts. In fact, the RICS estimated that in the Netherlands, 43 per cent. of total institutional property investment is in residential property. That compares with 26 per cent. in France,20 per cent. in Denmark and only 1 per cent. in the United Kingdom.
The RICS paper commented on that phenomenon:
“Research has shown that there is a high level of institutional investor interest in the private rented sector although a number of barriers to entry still remain. These barriers include market and political risks, the small scale and amateur nature of most landlords, small lot sizes and high transaction costs, the difficulty of assembling a portfolio that will yield adequate returns, high cost and poor quality management. These factors are amongst the reasons why the exposure of UK institutions is much lower than most other European countries.”
It was hoped that the introduction of the REITs regime would help to address some of those issues and to boost investment in the residential sector, but it is not clear that the regime, at least as it is now configured, is well designed to do that.
Going back slightly, the combined response by the British Property Federation, the International Property Forum and the RICS to the Government’s original consultation on property investment funds—PIFs—as UK REITs were originally known, suggested that they have the potential to generate major investment interest in the residential private property sector, and possibly also to fund registered social landlord developments, depending on the structure applied to the regime. Incidentally, that response noted that in the United States residential REIT investment accounts for about 15 per cent. of the total listed REITs sector.
More recently, having seen the new proposed regime, the BPF said:
“One difficulty for the private rented residential sector is that it is relatively small in the UK, at only 10% of the total residential stock and while it has served the higher end of the rental market well, there has been comparatively little servicing of the intermediate rental sectors, though there is growing evidence of activity in these areas by housing associations and possibly this is something that could in future be developed by residential REITS with the appropriate regulatory framework.”
I shall have more to say on that in a moment.
Although the Government have admittedly made a number of alterations to the regime in response to the consultation exercise—the Economic Secretary intimated that during deliberation on the previous clause—the regime as it is now configured still contains a number of features that make it relatively unattractive to companies that specialise in residential property. The first of these is the taxation regime itself and specifically the treatment of residential properties that have traditionally been held on trading accounts. We will deal with that in more detail when we reach clause 111, so I do not propose to reprise that whole argument now, suffice it to say that unless this is meaningfully addressed it threatens to act as a significant barrier to residential property companies seeking to achieve REIT status.
The second impediment is the condition that a UK REIT must be listed on a recognised stock exchange, such as the London stock exchange, and cannot be listed on smaller and more lightly regulated markets, such as AIM. This issue is a particular drawback for residential companies, which tend to be smaller in both market capitalisation and turnover than their commercial counterparts and which might not be suited to full listing on the stock exchange, but which, conversely, might be able to do well on AIM.
Indeed, according to the Daily Telegraph, some 60 property companies are listed on AIM at present, and between them they raised some £750 million in the first quarter of 2006 alone. Before the Economic Secretary retorts that the refusal to allow REITs to list on AIM is to reduce risks for investors, I would just remind him of the interview that he gave to the Financial Times on23 May, when he argued in favour of light-touch regulation in principle in the City, and as a result of which the paper reported:
“Ed Balls, the new Minister for the City, insisted yesterday that London must retain its ‘light-touch and risked based regulatory regime’”.
Andrew Flounders, from the law firm Cobbetts, argued that to imply that AIM is not sufficiently regulated to be included in the scheme is unreasonable. As he put it:
“The majority of investment managers are highly qualified and experienced in matters of financial risk and so would be able to identify whether or not an AIM-listed company is a good investment opportunity or imposes too many risks.”
There is a broader debate about the spread of REITs to markets such as AIM, which to some extent we covered in the Committee of the whole House. But, it is worth reiterating that this condition could act as a particular disincentive for residential property companies to convert to REIT status, not least because many of them may not hold sufficient properties, which are already highly regulated in terms of their rental income, to justify them seeking to convert to residential REIT status with a full listing on the London stock exchange.
As Angus McIntosh, a partner and head of research at property consultants King Sturge, pointed out:
“One of the main advantages to the Government is that it can use the REIT market to privately finance public initiatives, such as schools and social housing...By limiting restrictions on AIM, it will slow down its own public-private agenda. The Government needs to think outside the box.”
The third issue that I want to highlight in this context is the restriction on owner-occupied properties being included in the tax exempt portion of a REIT. While there may be good reasons for this, if interpreted literally, it could act as a bar to residential REITs which want to have a mixed portfolio including, say, shared ownership properties within their tax exempt business. Could the Economic Secretary clarify how shared ownership properties qualify in this context? For instance, were a residential property REIT eventually to be formed, which included in its portfolio both rented and shared ownership properties, would profits from both categories of property be included within the tax exempt business? And, for good measure, what would happen to the taxation of the gain if the remaining portion of a shared ownership property were sold to the part-owner/part-tenant in due course? 
Fourthly, what interaction does the Economic Secretary foresee, if any, between the REITs concept and housing associations? That has already cropped up and interests a number of hon. Members, not least because housing associations are now the major providers of social housing in this country, particularly given the trend towards block transfer of social housing stock from local authorities to registered social landlords, principally housing associations, which was largely initiated by the previous Conservative Government but which the Labour party has continued, with certain alterations, while in office.
The Royal Institution of Chartered Surveyors pointed out in a recent paper, which it kindly prepared for me on this subject, that housing associations may face certain impediments in seeking to convert to REIT status, not least the listing requirements that I referred to earlier. In addition, the 2 per cent. entry charge could represent a considerable cost for housing associations that have a sizeable portfolio.
Such points were echoed in a recent paper by the Affordable Rural Housing Commission, on the ability, or otherwise, of housing associations to convert to REIT status. If we are ever to do anything ambitious about social housing in this country, housing associations will need to be actively involved, but the REIT regime is not configured to facilitate that. As housing associations are among the largest landlords in most parts of the country, will the Minister indicate the role, if any, that he envisages housing associations will play in the REIT regime?
I suspect that we shall not solve all of the problems this morning. As Clint Eastwood famously said, a man’s got to know his limitations. However, from my perspective the REITs regime seems to have been drafted with commercial property principally in mind, and to be much less ambitious in relation to residential property. That is somewhat disappointing given the challenges that the country faces on housing policy, and arguably it is a missed opportunity that the Government should not have passed up.
I have sought to initiate a debate this morning and I hope that that debate will be revisited by other parties as the regime is rolled out. I look forward to hearing contributions from other Committee members and to the Minister’s reply.

George Young: I welcome you to the Chair, Mr. Benton, and I declare, yet again, my entry in the Register of Members’ Interests. As a footnote to the speech made by my hon. Friend the Member for Rayleigh I want to say that I believe this part of the Bill to be the most interesting. That may not be setting a high threshold, but a new vehicle is being introduced by these provisions, and they will secure a better operation of the property market.
I remain concerned about the issue that I mentioned in the debate on 3 May, because a vehicle that was designed for one purpose is now going to be used for another. Originally we had in mind a family saloon that would be at home on the residential estates of this country, whereas we are now getting a corporate limousine that would be more at home in the City and in the country’s office blocks and industrial centres.
As we heard in the earlier debate, the original concept of a REIT, or a HIT, or a PIF, was to promote investment in residential property, and I think that that is still the Government’s objective, because in the Budget speech the Chancellor said:
“To attract more capital into house building, we are now legislating to introduce for Britain the real estate investment trusts that are so successful in the USA.”—[Official Report,22 March 2006; Vol. 444, c. 293.]
However, when the Economic Secretary’s predecessor was pressed on what would actually happen after 1 January 2007, he conceded that the initial impact of the measure would be not on the residential sector but on the commercial sector. He said:
“At this stage the introduction of a UK REIT is intended to improve the situation for existing companies, but as a consequence of doing that we expect new companies to emerge in the marketplace.”—[Official Report, 3 May 2006; Vol. 445,c. 1040.]
In other words, there is no certainty that things are going to happen, but merely an expectation or a hope that there will be the response that the Economic Secretary and other Members in the Committee desire.
The midwife for REITs, as has already been mentioned, was Kate Barker. At the time of the 2003 Budget, she was asked to conduct a review of issues affecting housing supply in the UK. She was not asked to look at the commercial or office sectors, nor any other sector. When she published her interim report, she noted that the level of institutional investment in residential property in the UK was relatively low, and that there was a case for a new investment vehicle to encourage growth in such investment.
She summarised the arguments for that in paragraphs 7.32 and 7.33, saying:
“Despite the strong performance of property compared with other assets in recent years direct institutional investment in residential property is very low in the UK”,
and contrasting that with what happens in other countries, referring also to the history of housing investment trusts. When we reach clause 144, which winds up the HITs, it might be useful to have a gentle debate about why those did not take off—there was extensive consultation—and what action the Government took after 1996 to find out why they did not work and, if necessary, to change the regime.
The response to the important point made by the hon. Member for Wolverhampton, South-West about the impact on supply is in paragraph 7.35 of the Barker report, which states:
“These submissions have argued that changes to the tax system would encourage greater institutional investment in property which might have positive benefits for housing supply”.
It goes on to list the reasons, namely that
“the quality of private rented stock may improve through greater investment in the physical fabric...given a guaranteed institutional buyer, house builders may be more willing to increase supply; and...long-term investment may promote greater stability in the market, as institutional investors are typically less reliant on debt financing, and thus less vulnerable to interest rate changes.”
So Kate Barker took head-on the powerful argument deployed by the hon. Member for Wolverhampton, South-West that it is necessary to do something on the supply side as well as on the demand side.
When the report was published, the Government embarked on some consultation. At that point, the concept of REITs was changed from what Barker had originally envisaged—that they should be purely for residential property—to a broader vehicle that would embrace commercial property. That was received with alacrity by the commercial property sector. The shares were all marked up and the debate then moved away from what we ought to do about residential property to commercial property, and there was a debate about the entry charge and all the rest of it. The Government recognised that it was always going to be difficult to get institutional investment in the residential market, because in their second discussion paper, which was, I think, published last year, they said:
“In line with recommendations in Kate Barker's Review of Housing Supply, reform would also aim to address the unresponsive supply of housing through greater institutional investor participation in the residential market.”
Later, we shall consider my amendment to clause 218. My hopes are rising because, before we have even reached that, I have heard speeches from two other parties indicating sympathy for what I am trying to do, namely to ensure that the energies that are released by this new investment vehicle are directed towards the housing market. I hope that, before he reaches my amendment, the Economic Secretary will speak to the Minister for Housing and Planning, because she might well be very sympathetic to the objectives behind it.
At this stage, all that I want to do is to reiterate this question: during the whole consultation process, when the Government were clearly in dialogue with the commercial property sector, what parallel dialogue was taking place with the Council of Mortgage Lenders and the housing associations—the residential sector—to ensure that when 1 January 2007 arrived there was something on the runway waiting to take off rather than, as we heard in the debate on 3 May, a general hope or expectation that if they introduced this measure there would be a response?
The case for residential investment is far stronger than that for more investment in the commercial and office market. Of course, we need better offices, and we probably need more of them, but the housing market is the one that needs the investment. The Treasury seems to have responded disproportionately to the commercial aspect of the issue to the neglect of the residential sector. Can the Economic Secretary go beyond the rather disappointing response that we had on 3 May and give us some hope that this is a top priority and that every energy is being exercised—not just by the Treasury but by the relevant Departments—to ensure that the opportunity is seized, that they hit the ground running and that we get the extra investment in housing that I am sure all hon. Members want to see?

Edward Balls: We have had a wide-ranging debate that anticipates amendments on future clauses. The orderly thing for me to do is to respond to the general issues raised by the right hon. Member for North-West Hampshire that anticipate his amendment No. 218 and to respond in detail to that amendment when we come to clause 107.
It slightly concerns me that the right hon. Gentleman gave the impression that our response to the consultation exercise was disproportionate. One of the strengths of the consultation is that the Government have been willing to respond to a number of concerns to make sure that the regime works well.
A moment ago, I glanced at the progress that we made as a result of the consultation. We reduced the interest rate cover test from 2.5 per cent. to 1.25 per cent. in direct response to concerns from the industry, and we will debate that when we come to clause 115. We reduced the minimum requirement on net profits to be distributed from 95 per cent. to 90 per cent., and we will debate that when we come to clause 107. We moved to a much more flexible position on the 10 per cent. shareholding limit, as a result of which Liz Pearce, the chief executive of the British Property Federation, made the following comment:
“Government has listened to the property industry’s views and concerns. We are certainly optimistic that UK-REITS will make a significant contribution both to the UK property industry and to the country’s wider economic success.”
That is an endorsement of the consultation process. It shows that the Government have listened and responded to make UK REITs work.
I was slightly concerned that the right hon. Gentleman was suggesting that we responded too much. Responding properly to points made to us in a consultation exercise is the right way to go about things.

Julia Goldsworthy: We are happy that the British Property Federation welcome the proposals, but it largely represents commercial, rather than residential, property companies. I hope that the Economic Secretary will come to representatives of residential property companies who have also welcomed the proposals.

Edward Balls: The point I was making was that, in our consultation, we listened to a number of detailed points put to us from, in particular, the commercial property sector, but also from others. We have responded to those concerns. I was anxious that the right hon. Gentleman might be suggesting that the concerns of the commercial property sector and the City have been listened to too much, and I made the point that we had not been disproportionate but had done the right thing in responding to those concerns to make sure that the list of commercial companies who sign up to UK REITs is substantial and significant. I do not think that Conservative Members think we were wrong to listen to those concerns and respond in that way. They are making the point that we ought to do more in other areas as well, which is fine, but the rhetoric about listening too much to people from the City in Jaguars seemed to me to be a view that their Front-Bench spokesmen would not necessarily share.

Mark Francois: I acknowledge that the Government conducted a detailed consultation exercise and that they changed a number of aspects of the regime as a result. We all realise that. However, for clarification, bearing in mind that a number of commercial property companies have announced that they intend to apply for REITs status, how many residential property companies have made a similar announcement?

Edward Balls: I will answer that point in a second because I was going to come on to the issues concerning the residential sector. Without wanting to dwell too much on it, I was making the point that, in the early stages of his career when he was a Minister, the right hon. Gentleman probably pioneered the concept of arriving at the House of Commons on a bicycle. That concept has since been followed by others. However, we should not downplay the important role that the City of London and the commercial property sector play in our economy. He referred to my interview. As the Minister with responsibility for the City, I think that a thriving commercial property market in London, which will be delivered through the way in which we responded to the consultation, is good for the British economy and for the City. We should not downplay the importance of our response to the commercial property sector. It is an important part of the process. I will come to the right hon. Gentleman’s points in a minute.
On the point that was made a moment ago by the hon. Member for Falmouth and Camborne, I listed three different ways in which we responded to the consultation in three different areas. One of those ways was by reducing the distribution test from 95 per cent. to 90 per cent. That point was put to us during the consultation by, in particular, representatives of the residential sector. Our response also reflected the concerns of the residential sector. The consultation was overseen by my predecessor, so I was not directly involved in it, but I understand that it was widespread, and it certainly considered points put to us by the residential as well as the commercial sector.
I turn to the balance between residential and commercial property. As the right hon. Gentleman said, UK REITs are responding to the demand for pooled investment in the residential and commercial property sectors that has been seen in Britain and around the world. We have learned lessons from other countries, where all types of property can be invested in by REITs, and that is the approach that we are taking in the UK REIT regime. It has always been our intention to support investment in the commercial, as well as the residential, sector.
The consultation document that we published in 2004 was entitled “Promoting more flexible investment in property”. In it we discussed the importance of both the commercial and the residential sectors. The difference between the commercial and residential sectors is that commercial properties are usually rented but that the majority of properties in the residential sector are owner-occupied. As we say in the consultation document, the UK residential housing market is dominated by the owner-occupied sector. If one looks historically at why that is so, and therefore at why our private rented residential sector has developed so slowly over many decades, I suggest that the predominant reason—I think that Kate Barker would agree—is that restrictions in supply in the UK, along with a growing demand for housing, have made it possible for owner-occupiers to make substantial capital gains on housing; and that has encouraged people in that direction rather than in renting out their homes. That is why the points that I made to my hon. Friend the Member for Wolverhampton, South-West stand.
The fundamental problem in the UK has been a supply-side one, and that is the main driver for the UK private market being small, although I hope that it will soon be growing. Before 1997, the Conservative Government tried to address that issue. The right hon. Gentleman asked what lessons we had learned from the HIPs regime, and why it did not take off. The scheme was introduced in that Government’s later years; they were probably frustrated by their lack of progress over many years in turning around the low level of investment in the private residential sector. He will probably agree that the regime did not work; in our view, it was too prescriptive and insufficiently flexible and thus did not attract capital.
We are trying to deliver a regime that will be more flexible and more appropriate for residential property investors. The proof of the pudding will be in the eating, but an important part of our consultation was to learn from past failures in order to find ways that we could be more successful. I am grateful to the right hon. Gentleman for reminding me of some of the problems that were experienced in the past so that we can try to build upon them.
The Barker review was clear that the predominant problem was a supply-side one but that things could be done to improve the investment regime for residential property. That is why one of the recommendations in her interim report was to find ways to increase institutional participation in the private sector, as it would bring benefits through greater professionalism, improved standards of rented stock and a more efficient investment market. That is exactly what we want to achieve with the REITs regime. We want to encourage greater investment in residential as well as in commercial property.
Although, as the hon. Member for Rayleigh said, a number of the companies that initially said that they would establish a UK REIT were large companies in the commercial sector, the Financial Times and our own private researches suggest that a number of residential sector investors are considering switching to a UK REIT regime. It is not for me to give their names or to pre-empt the processes that they need to go through. The very nature of the business, as described by the hon. Member for Rayleigh, and the fact that these are likely to be smaller companies than the very large ones that I listed earlier means that they need to take time to work out how they will deal with this matter and work out the manner in which it will be done.
If, by the time that we get to the beginning of 2007, we have not seen significant residential investors establishing UK REITs, that will be a cause for concern. I said to the hon. Gentleman earlier that we would be keeping such matters under review, and that is one of the issues that we will need to look at closely. I do not think that we can conclude, at this stage, that the UK residential sector will not engage in this market. In fact, as I said, the early indications are the opposite, but we will definitely keep that under review.
As I said, we hope and believe that providing a vehicle for the residential as well as the commercial sectors will allow pension funds, charities and other institutions to invest in residential property and will provide a better and more efficient alternative to the individual buy-to-let market that we have seen over the past few years. We hope that that will have a significant impact on the private rented and commercial sectors.

Philip Dunne: Would the Economic Secretary agree that the measure imposes an unnecessary obstacle to small and medium-sized companies that are seeking to invest in the residential sector and that might also, for good commercial reason, wish to list on the AIM market, rather than the main market? Would he consider introducing an amendment to the Bill?

Edward Balls: As I progress through the points made in interventions by the right hon. Member for North-West Hampshire, I was moving in the direction of answering directly the four points put to me by the hon. Member for Rayleigh. If I do so now, that will take on board the points made by the hon. Member for Ludlow (Mr. Dunne).
The hon. Member for Rayleigh made four points about clause 111, AIM, shared ownership properties and housing associations. I shall address each of those in turn. The first point, which we will debate in detail when we come to amendment No. 209 to clause 111, concerns the trading stock rules, which the hon. Gentleman mentioned. The trading stock rules are one reason, according to published press reports, why Grainger—a listed property company that owns residential property—will not be converting.
I cannot comment on the particular needs of any individual company, but just to provide some clarification on this point and to reiterate points made consistently through the consultation process, we are providing in the Bill a much more generous tax regime for investors investing in bricks and mortar, for whom the substantial portion of their income comes from renting. That is why we are providing in the Bill a clear ring fence between activity that is appropriate for tax exemption—the rental income—and activity that is not, such as trading profits. Many of the debates that we will have later will, potentially, be about exactly how the line is drawn between schedule 1 and schedule 4 activities.
Any company can join the regime, provided that at least 75 per cent. of its activity is in rental income. That provision is consistent with the experience of other regimes around the world and has survived intact through the consultation process. There is no reason why that requirement should impact on residential property with a more deleterious effect relative to commercial property. We are trying to ensure that we support investment for the long term in the rental market, rather than finding ways in which we could tax advantage the short-term dipping in and out of investment for capital gains purposes. We have been consistent about that. As the hon. Member for Rayleigh said, we can debate that again when we come to clause 111. However, the tax models that we have put in place achieve our objectives while protecting the Exchequer and do not impact negatively on the residential sector relative to the commercial property sector.
The hon. Gentleman’s second point was about the alternative investment market. As he said, we debated that in detail on the Floor of the House. Also, we made it clear that, in our view, excluding AIM is right, but we have said that we will keep the matter under review. To reiterate briefly the points made on the Floor of the House, we have never said—and it would be wrong to say—that AIM is an unregulated exchange; it is not. It exists to provide small companies with a regime with an even lighter touch, in order to encourage them into listing before they move on to the more onerous requirements of a full listing, which involves regulation not simply from the exchange itself but from the Financial Services Authority. That is what occurs when one moves into a full listing on the stock exchange.
We have encouraged the development of AIM precisely to allow that progression. One of the great strengths of AIM is that it has taken off and grown substantially in recent years, providing such a progression in London. Companies start off under the AIM regime precisely because they do not have to take on the full regulatory burden or provide the protection for investors that is needed when one moves into a full listing.

Brooks Newmark: Does the Economic Secretary not respect the fact that AIM is one of the most successful markets in the world for small companies? Allowing REITs to be listed on AIM will give a boost to a market that is already highly respected, and that is not completely unregulated. That would be welcomed by those already involved in the AIM industry. I highlight the fact that, in the United States, which has the most mature REITs market in the world, the ratio of unlisted to listed is 4:1; there are four unlisted REITs for every listed REIT. I ask him once again to consider allowing AIM to be a viable market for REITs.

Edward Balls: I fear that we are at risk of repeating the debate on the Floor of the House. In that debate, some indicated that they did not see the strengths of the role of the AIM market, but other Labour Members and I are fully committed to the role that AIM plays; it has a hugely important role in our economy, and the fact that it has grown in importance and scale is a great strength for our economy and the City of London.
AIM has succeeded because it provides a less regulatory, and therefore more risky, environment for investors than a full listing. That is not to criticise AIM or to do it down, and I object to the hon. Gentleman’s suggestion that to make that point is somehow to disparage AIM. The very purpose of AIM is precisely to provide a less regulated and therefore more risky environment for investors. That is its strength, not its weakness. The questions to consider when trying to encourage the development of that market is what the right way is to provide a tax incentive, and whether we should provide it in the smaller and more risky environment of AIM, or in the more regulated and secure listing environment of the London stock exchange. The judgment that we have come to, at this stage, is that allowing REITs into that more risky environment would not be the right route to take, for reasons that were set out on the Floor of the House.
It will be for companies to consider at what stage it makes sense for them to move from the AIM environment to a full listing. Under the new regime, one of the advantages of a property company making that move is that they could then move into the REITs regime. I hope that more companies progress from AIM into a full listing to benefit from the REITs regime. AIM is supposed to help people make that move from the less established and regulated AIM environment to a full listing, with all the benefits that that confers. Those benefits will be good for companies, as they make their move.
There is another point to make: if we were to allow companies with shares listed on AIM to be eligible for the regime, we would also have to extend the position to companies listed on similar markets in the European Union. We are concerned about the potential risk of allowing that to happen, not just to the Exchequer but to investors.
The hon. Gentleman’s second argument was on the wider listing obligations that will need to be taken on. The provision will not restrict the number of residential REITs; in fact we hope that it will encourage more residential REITs to obtain a full listing. I hope that with those remarks I have answered the hon. Gentleman’s second question consistently with comments made on the Floor of the House and the commitment to keep the matter under review. I understood that the hon. Member for Rayleigh welcomed that commitment. I have committed today that we will look at the development of UK residential REITs over the course of this year. It is no surprise to me, and I would imagine not to the hon. Gentleman either, that the residential sector has not moved as quickly as British Land, Hammerson, Land Securities or Great Portland Estates, given that it is smaller and that companies that invest in it also tend to be smaller. At this stage, it is not right to be pessimistic. We will debate in a moment the difficulties of the amendment proposed by the right hon. Member for North-West Hampshire.
The third question that the hon. Member for Rayleigh asked concerned shared ownership, on which I think I can provide reassurance. Rent from shared property will count as tax-exempt rental income. Gains from the sale of parts to tenants will be exempt from tax, and the part owned by a REIT will be within the ring fence and so will be able to be included in the REIT. If that does not answer the hon. Gentleman’s question then, to refer back to the debates on Tuesday, I shall straddle for a while until I am able to provide him with further assurance.
The hon. Gentleman’s fourth point was on the interaction between REITs and housing associations. As he knows, the UK regime is being introduced fundamentally to remove tax distortions in the property market. There will purposely be no distinction between commercial and residential property. We hope that housing associations will be part of the development of REITs in the coming months. The indications to us and in public are that they are considering establishing UK REITs. One of the matters that we must all follow is whether that happens. If not, we will need to re-examine the matter, and I have made the commitment to the hon. Gentleman to do so. We intend to support both the commercial and residential property sectors, but we cannot do so in a way that would leave us to take undue risks for either the Exchequer or small investors. That is why we are putting in place a regime that is fit for purpose.

Mark Francois: I should like, if I may, briefly to reply to some of what the Economic Secretary said. My right hon. Friend the Member for North-West Hampshire has considerable experience in this area, and I urge the Economic Secretary to listen carefully to the points that he makes, not least on clause 107.
I am grateful for the Economic Secretary’s reply and clarification on shared ownership. There was some uncertainty about where shared ownership properties would sit, and he has made the situation reasonably clear. I thank him for that, and for his commitment that the Government will review the status of residential REITs once the regime is up and running. We have expressed genuine concern about that, and he has said that the Government will examine the matter once the regime has been rolled out. He said that if there was not a significant number of residential REITs, the Government might take action. I note that he did not define “significant” and I suspect that he would be reluctant to do so, but he did give a commitment to review the matter, which I welcome.
The point about AIM crops up again and again, and I was not entirely convinced by the Economic Secretary’s answer. I shall put down a marker that that is something that we may wish to pursue on Report in one way or another.
Having initiated the debate, as was my purpose this morning, I think that we have given it a good go. There is still a potential weakness in the regime and the Committee has done a good job in ventilating that point this morning. We are grateful for the Economic Secretary’s commitment to review the issue, if necessary, and at that point I shall end my remarks happy and we shall see how the process rolls out in practice.

Edward Balls: I would just like to make three brief points. First, I appreciate the expertise of the right hon. Member for North-West Hampshire and I would be pleased to have some more detailed discussions with him: it would be of benefit to me. As he will understand, I have come to this issue late in the consultation process and I would be happy to take such an opportunity. As I said earlier, that would partly be to understand why some past initiatives did not work, but also to get his advice. He has expertise in the matter, as do other hon. Members, and I would welcome the opportunity to speak to him about it.
Secondly, the hon. Member for Rayleigh challenged us to raise our level of ambition regarding social housing. I challenge him to raise his level of ambition on social housing, and more broadly on the implementation of the Barker report. Part of the reason we have a problem with housing in our country is because for decades—particularly the last two—there has been severe underinvestment in private and social housing. The increase in social housing investment has been substantial in recent years, but as the hon. Gentleman knows, that has been from a very low base. That base was low because of the underinvestment we inherited in 1997.

Mark Francois: I am surprised that the Economic Secretary wanted to get into this territory. Why has the number of social housing units built since 1997 dropped dramatically—under this Government?

Edward Balls: I am very happy to answer that question. When we came into Government in 1997, we were told that the backlog of repairs and indecency in homes in our country was so significant that even if we spent£19 billion over many years, we would still—[Interruption.] The decision was made in 1997 that we needed to invest to improve the quality of homes because of the huge deterioration in the standard that had occurred.
I am happy to say to the hon. Gentleman that in my view we did not quite get the balance right. We should have gone slightly more slowly on tackling the backlog in order to invest slightly more in social housing. Kate Barker told us, in her report, that we need to raise the level of social housing. If one looks, one sees that there has been an increase in social housing since the 2002 and 2004 spending reviews. The reason why we had a challenge was because the number of new homes being built was so low, and the property repairs backlog was so massive. I do not apologise at all that we tried to improve the quality of homes in our country for people in social housing. To be honest with the hon. Gentleman, what we inherited was a complete disgrace.
Thirdly, I assure the hon. Gentleman that in appreciating the expertise of Opposition Members and in agreeing that we are all challenged to improve the position of private and rented housing in our society and economy, we seek consensus. As challenged by Opposition Members, consensuses can often start at home and build out. I assure him that we do our best to ensure that there is a consensus on the home front, which I would like to extend to Opposition Members.

Question put and agreed to.

Clause 104 ordered to stand part of the Bill.

Schedule 16

Excluded business and Income

Mark Francois: I beg to move amendment No. 208, in page 84, line 32 [Vol II], leave out paragraph 11.
The schedule defines various categories of business and income that are specifically excluded from the REIT regime. Paragraph 11 defines as an excluded item “dividends from shares” in other REIT companies, which has the practical effect of preventing a REIT from being established to hold shares in other REITs. Will the Minister explain, in general terms, why the ability of one REIT to hold shares in another REIT in a different group is considered undesirable?
The general intention of REITs is to create a new and efficient form of collective investment in the property. In practice, individual investors—the small investors that the Government presumably wish to encourage—are likely to invest in underlying property businesses via intermediaries. A great deal of investment in the stock market, for example, takes place via funds of underlying shares. In some other jurisdictions, such as the United States, which has developed a successful REIT investment market, this restriction does not apply.

It being twenty-five minutes past Ten o’clock, The Chairman adjourned the Committee with Question put, pursuant to the Standing Order.

Adjourned till this day at fifteen minutes to Two o’clock.